Tech Portfolios Have Risks

Following the investigation, the Didi app was made unavailable on app stores, to stop it from signing up new users. Didi Global’s share price crashed 30% since the news came out last Friday (July 2, 2021).

While the market is seeking clarity in the ongoing investigation, there are some takeaways from this episode – not just for Didi, but for other tech giants, especially around environmental, social, and governance (ESG) risks. Here are three lessons.

Lesson 1: Legal Business =/= Ethical Business

First, internet businesses are very young and fast evolving. Regulatory coverage is still under development and is still slow to keep up with constant changes. That is why on paper, internet companies have far less involvement in regulated activities, compared to a utility provider or a property developer, as an example. But this doesn’t mean these companies are immune to regulatory scrutiny, which could tighten at any point.

To safeguard against this, a more relevant way to invest is to identify companies that have been upholding ethical standards, rather than sticking to the bare minimum of legal compliance. Most of the time regulations are less strict than society’s ethical values.

Lesson 2: This Risk Is Expensive

Unlike measuring volatility in the market, non-financial risks are difficult to quantify. But, with the benefit of hindsight, the impact of non-financial risks weighs on a company’s financials, and investors can be on the hook for big losses.  

For example, Facebook (FB) has been scrutinized by U.S. and EU regulators for its approach to privacy management, receiving a historic US$ 5 billion fine from the U.S. Federal Trade Commission in July 2019. This fine directly impacted the company’s financials. In addition, data from Sustainalytics shows that data-related breaches resulted in an average cost of US$ 3.9 million in 2019.

At this stage, privacy regulations are still emerging, and costs associated with compliance as well as cyberattacks are rising. An increasing amount of data being stored and processed in cloud computing environments also promote data privacy risks and costs.

Lesson 3: It’s Not Just Didi

Sustainalytics’ data shows that companies providing software and internet services are more vulnerable to data privacy and security than any other industry. This is obvious, thanks to the innate underlying business. Internet businesses can draw in massive amounts of data in the blink of an eye, and these companies directly or indirectly monetize the collection, processing and storing of sensitive user and client data. Thus, at the same time, risks of compromised accounts, misuse of personal information outside of agreed use, unlawful data sharing practices follow.

While the newly-listed Didi is not yet within our coverage universe, some of our favorite apps like Facebook, Snap Inc. (SNAP), Twitter Inc. (TWTR),and Uber Technologies Inc (UBER) have been found to be vulnerable to this issue. A case similar to Didi’s happened to its overseas peers Uber and Lyft. Precedent examples abound and these risks are unlikely to end with Didi. To top it all, as this specific risk isn’t confined by geographics, it makes sense for investors in tech companies to be mindful of such loopholes.

To end, data protection is a major loophole for the internet business and can translate into financial losses. It represents one facet of the numerous non-financial risks. When factoring in ESG issues exposed to a portfolio, investors should look from a broader perspective in ensuring a comprehensive and objective assessment.

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